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Legislation intended to create an SRO for investment advisers

The Chairman of the House Financial Services Committee (House Committee), Spencer Bachus (R-Ala.), intends to introduce legislation that would require both SEC- and state-registered investment advisers to join a self-regulatory organization (SRO) overseen by the SEC.

In January 2011, the SEC issued a report to the House Committee in which it recommended that the U.S. Congress enact legislation to require the creation of one or more SROs to oversee investment advisers, allocate the task to the Financial Industry Regulatory Authority (FINRA), or impose “user fees” on registered investment advisers to fund the SEC's investment adviser examination program. Currently, SEC-registered investment advisers are examined about every 11 years and the state examination process over state registered investment advisers varies in both quality and quantity from state-to-state.

Under the legislation, the SRO would be required to register with the SEC and meet certain criteria. The SRO would need to demonstrate to the SEC that it would be able to enforce compliance by its members, effectively examine those members, and submit an annual report to the SEC and Congress. The proposed legislation contemplates that certain advisers would be exempt from becoming a member of the SRO. Such exempt advisers would be those advisers who: (i) have 90 percent or more of assets under management attributable to non-U.S. clients; (ii) manage assets of less than $25 million; or (iii) manage venture capital funds and 401(k) plans.

It is believed that the creation of an SRO to regulate the registered investment advisers would allow the SEC to transfer more of its resources from its examination program to the area of complex and emerging issues within the securities industry that have arisen. It is no secret that the current system in which the SEC attempts to oversee and enhance its examination program over registered investment advisers is, at best, an uphill battle.

The North American Securities Administrators Association, representing the 50 state securities regulators, has voiced its opposition to the creation of an SRO that also would require state registered investment advisers to be a member. Apparently, most, if not all, of the state securities regulators believe that they can effectively regulate the investment advisers registered in their jurisdictions. The hedge fund industry also opposes creating an SRO to regulate investment advisers. In recent testimony before the House Committee, Richard Baker, head of the Managed Funds Association, testified that an SRO would, among other things, lack the expertise to conduct an effective examination over hedge fund managers. Others believe that dedicating fees imposed on investment advisers to the SEC for the hiring of staff examiners makes the most sense. The most common fear vocalized by detractors is that an SRO would need time (perhaps a couple of years) to hire and educate staff to conduct effective examinations. In addition, some dislike the fact that creating an SRO would, in effect, be another layer of regulation for its members.

What is clear to almost all parties is that the SEC needs help if it is to fulfill the examination program mandates under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Congressman Bachus believes that creating one or more SROs would best fulfill that mandate.